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Present Value of Free Cash Flow to the Firm (FCFF)

Difficulty: Intermediate

In discounted cash flow (DCF) valuation techniques the value of the stock is estimated based upon present value of some measure of cash flow. Free cash flow to the firm (FCFF) is generally described as cash flows after direct costs and before any payments to capital suppliers.


Intrinsic Stock Value (Valuation Summary)

Cisco Systems Inc., free cash flow to the firm (FCFF) forecast

USD $ in millions, except per share data

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Year Value FCFFt or Terminal value (TVt) Calculation Present value at 13.75%
01 FCFF0 13,620 
1 FCFF1 14,517  = 13,620  × (1 + 6.58%) 12,763 
2 FCFF2 15,507  = 14,517  × (1 + 6.82%) 11,985 
3 FCFF3 16,600  = 15,507  × (1 + 7.05%) 11,279 
4 FCFF4 17,808  = 16,600  × (1 + 7.28%) 10,637 
5 FCFF5 19,145  = 17,808  × (1 + 7.51%) 10,054 
5 Terminal value (TV5) 329,968  = 19,145  × (1 + 7.51%) ÷ (13.75% – 7.51%) 173,278 
Intrinsic value of Cisco's capital 229,995 
Less: Debt (fair value) 35,345 
Intrinsic value of Cisco's common stock 194,650 
Intrinsic value of Cisco's common stock (per share) $41.39
Current share price $42.40

Disclaimer!
Valuation is based on standard assumptions. There may exist specific factors relevant to stock value and omitted here. In such a case, the real stock value may differ significantly form the estimated. If you want to use the estimated intrinsic stock value in investment decision making process, do so at your own risk.


Weighted Average Cost of Capital (WACC)

Cisco Systems Inc., cost of capital

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Value1 Weight Required rate of return2 Calculation
Equity (fair value) 199,402  0.85 15.80%
Debt (fair value) 35,345  0.15 2.18% = 2.71% × (1 – 19.70%)

1 USD $ in millions

   Equity (fair value) = No. shares of common stock outstanding × Current share price
= 4,702,882,494 × $42.40 = $199,402,217,745.60

   Debt (fair value). See Details »

2 Required rate of return on equity is estimated by using CAPM. See Details »

   Required rate of return on debt. See Details »

   Required rate of return on debt is after tax.

   Estimated (average) effective income tax rate
= (21.80% + 16.90% + 19.80% + 19.20% + 11.10% + 20.80%) ÷ 6 = 19.70%

WACC = 13.75%


FCFF Growth Rate (g)

FCFF growth rate (g) implied by PRAT model

Cisco Systems Inc., PRAT model

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Average Jul 29, 2017 Jul 30, 2016 Jul 25, 2015 Jul 26, 2014 Jul 27, 2013 Jul 28, 2012
Selected Financial Data (USD $ in millions)
Interest expense 861  676  566  564  583  596 
Net income 9,609  10,739  8,981  7,853  9,983  8,041 
Effective income tax rate (EITR)1 21.80% 16.90% 19.80% 19.20% 11.10% 20.80%
Interest expense, after tax2 673  562  454  456  518  472 
Add: Cash dividends declared 5,511  4,750  4,086  3,758  3,310  1,501 
Interest expense (after tax) and dividends 6,184  5,312  4,540  4,214  3,828  1,973 
EBIT(1 – EITR)3 10,282  11,301  9,435  8,309  10,501  8,513 
Short-term debt 7,992  4,160  3,897  508  3,283  31 
Long-term debt, excluding current portion 25,725  24,483  21,457  20,401  12,928  16,297 
Total Cisco shareholders' equity 66,137  63,586  59,698  56,654  59,120  51,286 
Total capital 99,854  92,229  85,052  77,563  75,331  67,614 
Ratios
Retention rate (RR)4 0.40 0.53 0.52 0.49 0.64 0.77
Return on invested capital (ROIC)5 10.30% 12.25% 11.09% 10.71% 13.94% 12.59%
Averages
RR 0.56
ROIC 11.81%
Growth rate of FCFF (g)6 6.58%

2017 Calculations

2 Interest expense, after tax = Interest expense × (1 – EITR)
= 861 × (1 – 21.80%) = 673

3 EBIT(1 – EITR) = Net income + Interest expense, after tax
= 9,609 + 673 = 10,282

4 RR = [EBIT(1 – EITR) – Interest expense (after tax) and dividends] ÷ EBIT(1 – EITR)
= [10,2826,184] ÷ 10,282 = 0.40

5 ROIC = 100 × EBIT(1 – EITR) ÷ Total capital
= 100 × 10,282 ÷ 99,854 = 10.30%

6 g = RR × ROIC
= 0.56 × 11.81% = 6.58%


FCFF growth rate (g) implied by single-stage model

g = 100 × (Total capital, fair value0 × WACC – FCFF0) ÷ (Total capital, fair value0 + FCFF0)
= 100 × (234,747 × 13.75% – 13,620) ÷ (234,747 + 13,620) = 7.51%

where:
Total capital, fair value0 = current fair value of Cisco's debt and equity (USD $ in millions)
FCFF0 = last year Cisco's free cash flow to the firm (USD $ in millions)
WACC = weighted average cost of Cisco's capital


FCFF growth rate (g) forecast

Cisco Systems Inc., H-model

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Year Value gt
1 g1 6.58%
2 g2 6.82%
3 g3 7.05%
4 g4 7.28%
5 and thereafter g5 7.51%

where:
g1 is implied by PRAT model
g5 is implied by single-stage model
g2, g3 and g4 are calculated using linear interpoltion between g1 and g5

Calculations

g2 = g1 + (g5g1) × (2 – 1) ÷ (5 – 1)
= 6.58% + (7.51% – 6.58%) × (2 – 1) ÷ (5 – 1) = 6.82%

g3 = g1 + (g5g1) × (3 – 1) ÷ (5 – 1)
= 6.58% + (7.51% – 6.58%) × (3 – 1) ÷ (5 – 1) = 7.05%

g4 = g1 + (g5g1) × (4 – 1) ÷ (5 – 1)
= 6.58% + (7.51% – 6.58%) × (4 – 1) ÷ (5 – 1) = 7.28%